Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-61
COMP4-2. (continued)
Req. 6
(a) Current ratio = Current assets Current liabilities
= $49,000 $44,000
= 1.11
This suggests that Furniture Refinishers, Inc., generates $1.40 for every dollar of
assets.
(c) Net profit margin = Net income Sales
= $16,000 $70,000
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
CASES AND PROJECTS
FINANCIAL REPORTING AND ANALYSIS CASES
CP4–1.
1. American Eagle paid $132,234 thousand in income taxes in its 2008 fiscal year, as
disclosed in note 2 under “Supplemental Disclosures of Cash Flow Information.”
2. The quarter ended January 31, 2009, was its best quarter in terms of sales at
$905,713,000 (this quarter covered the holiday shopping season, the biggest part of
3. Other income (net) is an aggregate of many accounts, but a summary entry for them
4. As disclosed in Note 5, Accounts and Note Receivable consists of (in thousands):
Construction allowances
11,139
Merchandise sell-offs
17,057
Interest income
Marketing cost reimbursements
Credit card receivable
Merchandise vendor receivables
Other
Total
5. Fiscal year (dollars are in thousands)
2008:
Net Profit Margin
=
Net Income
=
$179,061
=
0.060
Sales
$2,988,866
2007:
Net Profit Margin
=
Net Income
=
$400,019
=
0.131
Sales
$3,055,419
Net Profit Margin
=
Net Income
=
$387,359
=
Sales
$2,794,409
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
CP4–2
2. The company reported $134,084 thousand in deferred rent. This information is
disclosed on the balance sheet.
3. Prepaid rent (an asset) represents rent that a company has paid in advance to its
landlords. If a company also rents property to tenants, deferred rent (a liability)
5. Interest Income is related to the company’s short-term and long-term marketable
securities (investments).
6. The company’s income statement accounts (revenues, expenses, gains, and losses)
7. Prepaid Expenses is an asset account. As such, it is a permanent account that
8. The company reported basic earnings per share of $1.20 for the year ended January
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
9. Year Ended (dollars in thousands)
1/31/09:
Net Profit Margin
=
Net Income
=
$199,364
=
0.109
Sales
$1,834,618
1/31/08:
Net Profit Margin
=
Net Income
=
$160,231
=
Sales
$1,507,724
1/31/07:
Net Profit Margin
=
Net Income
=
$116,206
=
0.095
Sales
$1,224,717
CP4–3.
1. American Eagle Outfitters reported an advertising expense of $79.7 million for the
most recent year (Note 2 under Advertising Costs). Urban Outfitters reported $45.6
million of advertising costs for the year. (See Note 2 under Advertising).
2.
American Eagle Outfitters
Urban Outfitters
Year
Ended
Advertising
Expense /
Net Sales
Advertising
Expense /
Net Sales
2009
79,700 / 2,988,866
2.7%
45,561 / 1,834,618
2.5%
2008
74,900 / 3,055,419
2.5%
40,828 / 1,507,724
2007
64,300 / 2,794,409
2.3%
sales while Urban Outfitters’ has decreased as a percentage of sales.
3.
Industry
Average
American Eagle
Outfitters
Urban
Outfitters
Advertising/Sales =
2.39%
2.7%
2.5%
Both American Eagle and Urban Outfitters are spending more on advertising as a
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4. Both accounting policies are similar indicating that advertising costs are expensed
when the marketing campaigns become publicly available. American Eagle
CP4–3. (continued)
5.
Year
Ended
American Eagle
Outfitters
Urban Outfitters
2009:
Net Profit
=
Net Income
$179,061
=
0.060
$199,364
=
0.109
Margin
Sales
$2,988,866
6.0%
$1,834,618
10.9%
2008:
Net Profit
=
Net Income
$400,019
=
0.131
$160,231
=
2007:
Net Profit
=
Net Income
$387,359
=
0.139
$116,206
=
0.095
6.
Industry
Average
American Eagle
Outfitters
Urban Outfitters
Net Profit Margin =
3.77%
6.0%
10.9%
Both companies, American Eagle Outfitters and Urban Outfitters have higher Net
Profit Margins than the average company in their industry. This is likely due to the
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-66
CP4–4.
Account
2011
Balance
Financial
Statement
Effect on
Cash Flows
1. Rent revenue
$508,000
Income statement
+ $492,000
2. Salary expense
71,000
Income statement
− 68,000
3. Maintenance supplies expense
9,150
Income statement
No effect
(1)
Rent Revenue
(2)
Salary Expense
(3) Maintenance
Supplies Expense
492,000 (a)
(e) 68,000
Used 9,150
16,000 (b)
508,000
(4)
Rent Receivable
(5) Receivables
from Employees
(6) Maintenance
Supplies
(b) 16,000
(g) 1,500
(h) 3,000
9,150 used
(7) Unearned
Rent Revenue
(8)
Salaries Payable
12,000 (c)
(d) 4,000
4,000 Bal.
Inferred
3,000 (f)
12,000
3,000
4,000 (d) to employees
1,500 (g) to employees
8,000 (i) to suppliers
4. Rent receivable
16,000
Balance sheet
No effect
5. Receivables from employees
Balance sheet
6. Maintenance supplies
Balance sheet
7. Unearned rent revenue
12,000
Balance sheet
8. Salaries payable
Balance sheet
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
CP4–5.
Req. 1
Unadjusted
Trial Balance
Adjusted
Trial Balance
Post-Closing
Trial Balance
Account
Debit
Credit
Debit
Credit
Debit
Credit
Cash
20,000
20,000
20,000
Maintenance supplies
500
200
200
Service equipment
90,000
90,000
90,000
service equipment
18,000
27,000
27,000
Remaining assets
42,500
42,500
42,500
Note payable, 8%
10,000
10,000
10,000
Interest payable
Income taxes payable
13,020
13,020
Wages payable
500
500
Unearned revenue
12,000
6,000
6,000
Contributed capital
50,000
56,000
50,000
Retained earnings
9,000
9,000
45,380
Service revenue
214,000
220,000
0
Expenses
160,000
183,620
0
313,000
313,000
336,320
336,320
152,700
152,700
Req. 2
(a) To record the amount of supplies used during 2011, $300, and to reduce the
supplies account to the amount remaining on hand at the end of 2011.
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-68
CP4–5. (continued)
Req. 3
Closing Entry on December 31, 2011:
Service revenue (from the adjusted trial balance) (−R) ……… 220,000
Retained earnings (+SE) …………………………………….. 36,380
Expenses (from the adjusted trial balance) (−E) ……… 183,620
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
CP4–6.
Transaction (a):
1. This transaction will affect Carey’s financial statements for 14 years (from 2011 to
2. Income statement:
Depreciation expense, as given $1,000 each year
3. Balance sheet at December 31, 2013:
Assets:
4. An adjusting entry each year over the life of the asset would be recorded to reflect
Transaction (b):
1. This transaction will affect Carey’s financial statements for 2 years—2013 and 2014-
2. The 2013 income statement should report rent revenue earned of $20,000 ($30,000
3. This transaction created a $10,000 liability ($30,000 – $20,000 = $10,000) as of
4. Yes, an adjusting entry must be made to (a) increase the Rent Revenue account by
$10,000 for two months’ rent earned in 2014 and (b) to decrease the liability to $0
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-70
CP4–6. (continued)
Transaction (c):
2. The $7,500 should be reported as wage expense in the 2013 income statement and
as a liability on the 2013 balance sheet. On January 5, 2014, the liability will be
3. Yes, an adjusting entry must be made to (a) record the $7,500 as an expense in
2013 (matching principle) and (b) to record the liability which will be paid in 2014.
December 31, 2013—Adjusting entry:
Wage expense (+E, −SE) …………………………. 7,500
Transaction (d):
1. Yes, service revenue of $45,000 (i.e., $60,000 x 3/4) should be recorded as earned
2. Recognition of revenue earned but not collected by the end of 2013 requires an
adjusting entry. This adjusting entry is necessary to (a) record the revenue earned
3. February 15, 2014—Completion of the last phase of the service contract and cash
collected in full:
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-71
CP4–7.
Req. 1
Adjusting entries:
(a)
Expenses (insurance) (+E, −SE) …………………………………
1
Prepaid insurance (−A) …………………………………….
1
To adjust for expired insurance.
(d)
Expenses (wages) (+E, −SE) ……………………………………..
3
Wages payable (+L) …………………………..…………….
3
To adjust for wages earned but not recorded or paid.
(e)
Income tax expense (+E, −SE) …………………………………..
5
Income taxes payable (+L) ………………………………..
5
To adjust for income tax expense.
Revenues (rent) (+R, +SE) ………………………………..
3
To adjust for rent revenue collected but unearned.
Req. 2
Closing entry (from the adjusted trial balance):
Revenues (−R) ………………………………………………………….
103
Retained earnings (+SE) ……………………………………….
15
Expenses (−E) ………………………………………………………
83
5
(b)
Rent receivable (+A) …………………………………………………
2
Revenues (rent) (+R, +SE) ………………………………..
2
To adjust for rent revenue earned but not yet collected.
(c)
Expenses (depreciation) (+E, −SE) ……………………………..
Accumulated depreciation (+XA, −A) …………………..
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
CP4–7. (continued)
Req. 3
(a) Shares outstanding: 1,000 shares (given) – no change all year.
(b) Interest expense: $20 thousand x .10 = $2 thousand.
(c) Ending balance in retained earnings:
Unadjusted balance, $(3,000) + Net income, $15,000 = $12,000.
(f) Net income of $15,000 was computed on the basis of accrual accounting concepts.
Revenue is recognized when earned and expenses recorded when incurred
regardless of the timing of the respective cash flows. Cash inflows, in addition to
certain revenues, were from numerous sources such as the issuance of capital
stock, borrowing, and revenue collected in advance. Similarly, cash outflows were,
in addition to certain expenses, due to numerous transactions such as the purchase
of operational and other assets, prepaid insurance, and dividends to stockholders.
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-73
CP4–8.
Req. 1
CRYSTAL’S DAY SPA AND SALON, INC.
Income Statement
For the Year Ended December 31, 2012
Items
Cash
Basis Per
Crystal’s
Statement
Explanation of Changes
Corrected
Basis
Revenues:
Spa fees
$1,215,000
See * below.
$1,102,000
Expenses:
Depreciation
0
Given for 2012 (c)
20,500
Total expenses
792,100
801,625
Net income
$ 422,900
$ 300,375
*
Cash collected for spa fees
$1,215,000
Fees earned in prior years (a)
-142,000
Fees earned in 2012 but not yet collected (b)
Fees earned in 2012
Beg. 3,125
End. 5,200
Office rent
130,000
Exclude rent for Jan. 2013 ($130,000 ÷ 13) (g)
Telephone
See ** below.
Salaries
Add December 2012 salary ($18,000 ÷ 12) (e)
Supplies
31,900
See *** below.
29,825
Miscellaneous
No change
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-74
CP4–8. (continued)
Req. 2
Memo to Crystal Mullinex should include the following:
(1) Net income was overstated by $122,525 because of inappropriate recognition of
revenue (overstated by $113,000) and expenses (understated by $9,525).
(2) Some other items the parties should consider in the pricing decision:
(a) A correct balance sheet at December 31, 2012.
(b) Collectability of any receivables (if they are to be sold with the business).
(c) Any liabilities of the spa to be assumed by the purchaser.
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
CRITICAL THINKING CASES
CP4–9.
Req. 1
2012
Adjusting Entries
Debit
Credit
12/31
(a)
Supplies expense (+E, −SE)…………………
2,200
Supplies (−A)……………………………….
(b)
Insurance expense (+E, −SE)…………………….
3,000
Prepaid insurance (−A)……………………
(c)
Depreciation expense (+E, −SE)…………………
8,000
Accumulated depreciation (+XA, −A)…….
(d)
Salaries expense (+E, −SE)…………………………
3,200
Salaries payable (+L)………………………
3,200
(e)
Transportation revenue (−R, −SE) ………
7,000
Unearned transportation revenue (+L)……
7,000
Transportation revenue is too high and needs to be
created for the appropriate amount.
Income tax expense (+E, −SE)……………………
Income tax payable (+L)……………………
To record 2011 income tax computation:
Transportation revenue: $85,000 − $7,000 = $78,000
Expenses: $47,000 + $2,200 + $3,000
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-76
CP4–9. (continued)
Req. 2
STOSCHECK MOVING CORPORATION
Corrections to 2012 Financial Statements
Amounts
Reported
Changes
Debit Credit
Corrected
Amounts
2012 Income Statement:
Revenue:
Transportation revenue
$ 85,000
e
7,000
$ 78,000
Expenses:
Salaries expense
17,000
d
3,200
20,200
Income tax expense
0
f
5,110
5,110
Total expenses
47,000
68,510
Net income
$ 38,000
$ 9,490
December 31, 2012, Balance Sheet
Assets:
Current Assets:
Cash
$ 2,000
$ 2,000
Receivables
3,000
3,000
Supplies
4,000
a
2,200
Prepaid insurance
b
3,000
Total current assets
15,000
9,800
Equipment
40,000
40,000
Less: Accumulated deprec.
8,000
Remaining assets
Total assets
$82,000
$68,800
Liabilities:
Current Liabilities:
Accounts payable
$ 9,000
$ 9,000
Salaries payable
d
3,200
3,200
Unearned transportation revenue
e
7,000
7,000
Income tax payable
f
5,110
Total current liabilities
Supplies expense
12,000
a
2,200
14,200
Other expenses
18,000
18,000
Insurance expense
b
3,000
3,000
Depreciation expense
8,000
8,000
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-77
Stockholders’ Equity
Contributed capital
35,000
35,000
Retained earnings
38,000
9,490
equity
CP4–9. (continued)
Req. 3
Omission of the adjusting entries caused:
(a) Net income to be overstated by $28,510.
Req. 4
(a) Earnings per share:
Unadjusted — $38,000 net income 10,000 shares = $3.80 per share
Adjusted — $ 9,490 net income 10,000 shares = $0.95 per share
Total stockholders’ equity
73,000
44,490
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
CP4–9. (continued)
Req. 5
To the Stockholders of Stoscheck Moving Corporation:
We regret to inform you that your request for a $30,000 loan has been denied.
A review of key financial ratios indicates that the adjustments caused earnings per
share and net profit margin to decline. Net profit margin declined from 44.7% to 12.2%.
The adjusted ratios, however, would be compared to those of other start-up companies
in the same industry.
We require that there be sufficient collateral pledged against the loan before we can
consider it. The current market value of the equipment may be able to provide
additional collateral against which the loan could be secured. Your personal
investments may also be considered viable collateral if you are willing to sign an
agreement pledging these assets as collateral for the loan. This is a common
requirement for small start-up businesses.
CP4–10.
Req. 1 Cash from Operations: $24,000
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-79
CP4–10. (continued)
Req. 4
Adjusting entry (cash receipt credited to Unearned Subscriptions Revenue):
Unearned Subscriptions Revenue (L)
Subscriptions Revenue (R)
9/1 24,000
Req. 5
a. $6,000 revenue target based on cash sales:
This target is not clearly defined. Does management mean any cash
subscriptions received during the period? Your region generated $24,000 in
cash subscriptions. By this assumption, your region far exceeded the company’s
target. You may be entitled to a generous bonus due to your strong
performance.
management.
b. $6,000 revenue target based on accrual accounting:
This situation is the same as the second assumption under a. Your region
earned $1,333 less than expected by the company.
FINANCIAL REPORTING AND ANLYSIS PROJECT
CP4–11.
AJE 4,667
AJE 4,667
End. 19,333
End. 4,667